Landmark Bank Overhaul Ignores Many Financial Problems

Congress is getting tougher on both borrowers and lenders blamed for inflating a housing bubble that, when it popped, plunged the nation into a severe recession two years ago.

Under sweeping financial overhauls that have now passed the House and Senate, home buyers won't be able to get a mortgage without producing pay stubs or other evidence they can make their monthly payments.

A new consumer watchdog will police lenders who offer impossible-to-resist subprime mortgages and then jack up the interest rates to impossible-to-pay levels.

The bills, which still have to be blended into one that could reach the president's desk this summer, also shine more light on complex but hidden financial instruments, the "derivatives" that made long-odds bets on whether Americans could make payments on mortgages they never should have qualified for.

The legislation takes aim at the credit and securities markets that collapsed when those bets turned out to be wrong, prompting Congress and the Federal Reserve to put up more than $2 trillion to prevent a panic that might well have triggered a global depression.

Still, for all their ambition, lawmakers left some gaping questions on how to tackle some of the most significant financial sector weaknesses exposed by the 2008 financial meltdown — from mortgage giants Fannie Mae and Freddie Mac to unsettled disputes over banks and their derivatives business and requirements that they hold more capital.

And in the rough and tumble give and take of writing laws, they rejected tougher measures that would have forced behemoth banks to downsize, required securitizers to retain some credit risk in their loans, and compelled home buyers to put a down payment on their loans.

If anything, however, the political environment has grown more populist since the House passed its legislation in December — a trend that will likely protect the tougher provisions in both bills.

Here's a broad look at elements of the bill and what they do and don't do to avoid a repeat of a financial crisis:

LENDING:

In passing its sweeping rewrite of financial regulations, the Senate does not embrace Shakespeare's admonition: "Neither a borrower nor a lender be."

But it makes it tougher.

Mortgage brokers won't be able to make money on high interest loans; buyers won't be able to lie about their ability to pay as loan officers look the other way.

The Senate rejected a proposal that would have required home buyers to place a minimum 5 percent down payment on their mortgages.

It also rolled back a provision that would have required lenders who sell their mortgages to hold 5 percent of the credit risk as "skin in the game," designed to ensure they wrote safe loans. Instead, lenders who write loans that meet strict underwriting standards could sell their loans and avoid the risk retention requirement.

Lending would be overseen by a new agency. The House sets up a stand-alone Consumer Financial Protection Agency with rule writing powers. The Senate sets up an independent bureau within the Federal Reserve and its rules could be vetoed by the oversight council of regulators. House Financial Service Committee Chairman Barney Frank indicated the agency would not likely end up in the Fed, but otherwise said the authorities of the two entities were similar.

"I thought we'd have a major fight over the independence of the CFPA," he said. "Not a problem."

Fixing the government-sponsored mortgage giants Fannie Mae and Freddie Mac was put off for another day.

The two companies lowered their standards for borrowers during the housing boom and now those high-risk loans are defaulting at a record pace. The government has been forced to rescue them to the tune of $145 billion.

Administration officials have said an overhaul of the two will be a priority next year. And, as a Band-Aid measure, the Senate approved a provision ordering a study, which is already under way at Treasury.

"What we did — and I would be the first to admit it, being the author of the provision — is fairly anemic in light of what we need to be doing," Senate Banking Committee Chairman Christopher Dodd conceded.

TOO BIG TO FAIL:

The legislation creates a liquidation system for large, interconnected firms, whereby the Federal Deposit Insurance Corp. would step in to wind down large firms that pose a risk to the system. Shareholders and unsecured creditors would be wiped out, management would be fired and counterparties in their complex transactions would not necessarily be made whole.

The Senate eliminated a $50 billion liquidation fund, prepaid by the largest financial institutions. The House has its own fund. Frank, no fan of the fund, said Thursday that it would come out during a House-Senate conference on the bill.

That means that taxpayers would have to front the costs of liquidation.

And though the Senate bill specifically says taxpayers will suffer no loses when a large firm fails, the Senate bill gives the FDIC up to five years to wind down a firm.

Both bills would require banks to hold more money to cover their debts. The House bill has a specific leverage cap on financial institutions of 15-1 debt-to-net capital ratio. The Senate requires banks with more than $250 billion in assets to meet capital standards at least as strict as those that apply to smaller banks. That provision passed unanimously, but policy makers are taking a second look, saying that standard could have unintended consequences. It could be altered or removed in negotiations with the House.

MARKETS:

Both the House and the Senate require complex securities known as derivatives to lose their unregulated status and be traded or cleared through exchanges. That would provide a third party to help back up the bets in the event one of the two participants in the trade defaults.

The House bill, however, grants more corporate exceptions from regulation than the Senate bill does.

The Senate bill has a provision that would force banks to spin off all their derivatives business. That means they would not only be unable to make their own derivatives bets, they also could not make derivatives markets for their clients. Bank regulators and administration officials fear that provision could drive derivatives into unregulated markets.

They say that, too, will be altered or removed in discussions with the House.

Congress is getting tougher on both borrowers and lenders blamed for inflating a housing bubble that, when it popped, plunged the nation into a severe recession two years ago.
Under sweeping financial overhauls that have now passed the House and Senate, home buyers won't...